CHAPTER 26 Debtor-Creditor Relations and Bankruptcy

CHAPTER 26CHAPTER 26

Debtor-Creditor Relations and Bankruptcy

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LOANS CATEGORIZED BY LENDER

LOANS CATEGORIZED BY LENDER

Commercial loans are most commonly made by banks, insurance companies, and purchasers of commercial paper, that is, short-term corporate indebtedness. Banks and insurance companies are highly regulated by federal and state statutes. These statutes affects sources, availability of funds, flexibility of terms and interest rates

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LOANS CATEGORIZED BY PURPOSE

LOANS CATEGORIZED BY PURPOSE

Term Loans - loans for a specific purpose, such as an acquisition or a construction project. A specified amount is borrowed and paid either in a lump sum or in installments.

Revolving Loans or Line of Credit - allows the borrower to borrow and re-borrow (“revolving”) whatever sums required, up to a specified maximum amount

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SECURED LOANS SECURED LOANS Collateral - is property belonging to the borrower

that will become the lender’s if the loan is not repaid. A loan backed up by collateral is known as a secured loan.

Foreclosure - If the borrower fails to repay a secured loan, the lender, in addition to suing for return of the monies lent, may foreclose on - that is, take possession of - the collateral and either sell it to pay off the debt or keep it in satisfaction of the debt.

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LOAN AGREEMENTS LOAN AGREEMENTS The Parties - lender and borrower. A borrower can be an

individual person or a business entity such as a corporation. If two or more banks together it is called a syndicated loan. A participation loan is a loan in which the original lender sells shares to other parties, called participants. Each participant acquires an undivided interest in the loan. The sale may be made without the borrower’s involvement.

Commitment to Make a Loan - a “term sheet” is a letter outlining the terms and conditions on which the lender will lend. A commitment to make a loan need not be in writing to be enforceable.

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LOAN AGREEMENTSLOAN AGREEMENTS Description of the Loan - A loan agreement contains the

lender’s promise to lend a specified amount of money how the funds will be disbursed, rate of interest and repayment terms. – Mechanics of Funding - usually by wire transfer or

cashier’s check.– Interest Rates - fixed or floating or fluctuating throughout

the life of the loan based on, for example, the bank’s prime rate (the lowest published rate of interest at which the bank lends to its best and most creditworthy commercial customers). Alternatively the floating rate may be pegged to the London Interbank Offered Rate (LIBOR) or to the certificate of deposit (CD) rate.

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DESCRIPTION OF THE LOANDESCRIPTION OF THE LOAN

– Computation of Interest - Interest is generally computed on a daily basis, usually by the 365/360 method, where the nominal annual interest rate is divided by 360, and the resulting daily rate is then multiplied by the outstanding principal amount and the actual number of days in the payment period.

– Repayment Terms - flexible based on parties agreement.

– Asset-Based Loans - amount of loan is determined according to the levels of assets available from time to time.

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LOAN AGREEMENTSLOAN AGREEMENTS Representations and Warranties - before committing

to make a loan, a lender will investigate the potential borrower’s financial condition and creditworthiness. It will also require the borrower to confirm his legal status (sole proprietor or other business entity), and other material issues that the lender may require prior to a loan commitment.

Conditions to Closing - lenders require a borrower to: demonstrate that she has the authority to approve the loan, including corporate resolutions, pay any fees at closing and sign all documents.

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Conditions Precedent - The loan agreement will specify the conditions that must be met before the lender’s obligations arise under the agreement. If any condition is not met, the agreement may be rescinded and the bank may decide not to disburse the funds.

Covenants - borrower’s promises to the lender that it will or will not take specific actions as long as either a commitment or a loan is outstanding. If a covenant is breached, the lender is free to terminate the loan.– Affirmative Covenants - state what the borrower undertakes to do.– Negative Covenants - state what the borrower undertakes not to

do.– Scope. Covenants are generally heavily negotiated.

LOAN AGREEMENTSLOAN AGREEMENTS

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Events of Default - the events that will trigger the lender’s right to terminate (or call) the loan, accelerate the repayment obligations, and, if the loan is secured, take possession of the property securing the loan, e.g., failure to pay on time any amounts due under the loan agreement and fraud.

Remedies for Default - optional for lender. If the lender waives a default - that is, decides not to exercise any of its remedies - it may exact additional consideration from the borrower, in the form of an increase in the interest rate or additional security.

LOAN AGREEMENTSLOAN AGREEMENTS

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SECURED TRANSACTIONS UNDER

THE UCC ARTICLE 9


THE UCC ARTICLE 9 Article 9 applies “to any transaction

(regardless of its form) which is intended to create a security interest in personal property or fixtures including goods, documents, instruments, general intangibles, chattel paper or accounts.”

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Terminology - UCC uses the single term “security interest” to signify any interest in personal property or fixtures that are used as collateral to secure payment by the “debtor”(borrower) for the performance of an obligation to the “secured party” (lender).

Formal Requisites - for a security interest to be enforceable, the UCC requires that value has been given in exchange for it, and that the debtor has rights in the collateral. When all of the requirements have been met, a security interest is said to have attached.


THE UCC ARTICLE 9


THE UCC ARTICLE 9

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Rights and Remedies - Article 9 sets forth the rights of the secured party as against other creditors of the debtor; the rules for perfecting a security interest, i.e., making it valid as against other creditors of the debtor; and the remedies available to a secured party when a debtor defaults.

Scope of Article 9 - applies to most consensual security interests; but some security interests are outside of its scope. Exemptions include:– Liens on real property.– Preemption on ship mortgages, mechanic’s liens, and aircraft liens.– Security interests subject to a landlord’s lien, to a lien given by

statute or other rule of law for services or materials, or to a right of setoff.

– Security interests in securities are governed by Article 8 of the UCC.


THE UCC ARTICLE 9


THE UCC ARTICLE 9

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SECURITY AGREEMENTS

SECURITY AGREEMENTS

A security agreement identifies the parties and the property to be used as collateral. It may also specify the debtor’s obligations and the lender’s remedies in case of default.

Parties to the Agreement - in a loan, the secured party is the lender, the debtor is the borrower, if it owns the collateral or if the owner has authorized it to use the property for collateral. If the third-party owner acts as a guarantor of the borrower’s obligation, it may also be referred to as the debtor.

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SECURITY AGREEMENTS

SECURITY AGREEMENTS Granting Clause - the security agreement must be signed by the debtor

and must expressly grant a security interest in some specified property. Description of the Collateral - the description of the collateral need not

be specific as long as it reasonably identifies what is described. Frequently, a secured party will take a security interest in all of the assets of the debtor - not only fixed assets, inventory, and receivables, but also trademarks, trade names, goodwill, licenses, books, and records.– After-Acquired Property - acquired by the debtor after the execution

of the security agreement subject to a security interest. – Proceeds - unless otherwise agreed, a security agreement gives the

secured party a security interest in the proceeds if the collateral is sold, exchanged, collected, or otherwise disposed of and gives the secured party a floating lien.

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SECURITY AGREEMENTS

SECURITY AGREEMENTS

Debtor’s Obligations - all terms and conditions agreed to in the security agreement, including the debt, interest and related fees, charges, and expenses.

Cross-Collateralization - collateral for one loan may be used to secure obligations under another loan.

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SECURITY AGREEMENTS

SECURITY AGREEMENTS

Remedies for Default - in the event of default, the secured party has the right to take possession of the collateral--without judicial process-- if this can be done without breach of the peace.– The secured party must then dispose of the collateral at a

public or private sale.– If there is a surplus from the sale of the collateral, the secured

party is required to return it to the debtor.– If there is a deficiency, the debtor remains liable for that

amount.– The parties may agree to apply the proceeds of a foreclosure

sale to attorney’s fees and legal expenses, or they may agree that the debtor will assemble the collateral and make it available to the secured party at a designated place.

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PERFECTING A SECURITY INTEREST


A lender protects its security interest by perfecting it, which makes it valid against other creditors of the debtor and against a trustee in bankruptcy of the debtor.

Methods of Perfection.– By Possession - a security interest in, for example, letters of credit,

goods, money or negotiable documents is perfected by the secured party’s taking possession of the collateral.

– By Filing - for other types of collateral, perfection is accomplished by filing a financing statement (known as a UCC-1 form).

– Automatic Perfection - security interests that require neither possession nor filing for perfection, e.g., a purchase-money security interest in consumer goods created when the seller of consumer goods lends the buyer the money with which to buy them. Automatic perfection is of limited duration.

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Filing Procedure - perfection by filing provides notice “to the world” that the assets of one person are subject to the security interest of another. A centralized system gives effective public notice that property in the possession and under the apparent control of the debtor is actually subject to the rights of another.

Where to File - with the secretary of state in the state in which the property is located or, in the case of real property (including fixtures, growing crops, timber, or minerals) with the county recorder’s office in the county where the real property is located.

What to File - a financing statement must be filed to perfect a non-possessory security interest.

When to File - generally, the first secured party to file has priority over other parties with security interests in the same debtor’s property, except in the case of a purchase-money security interest.



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EQUIPMENT LEASING EQUIPMENT LEASING Parties - When equipment is leased, three parties are involved: the seller

(lessor) of the equipment, the leasing company, and the user (lessee) of the equipment.

Finance Lease - equipment lease that serves the purpose of financing is known as a finance lease.– Lessor has control over the use, alteration, and location of the equipment. – Lessee is required to keep the equipment in good repair and to insure it

against loss or damage.– Lessor is given a security interest in the equipment, and it may foreclose

and sell the equipment in the event of default by the user.– Finance lease is treated as a long-term debt of the lessee, who is deemed

to own the leased equipment; the lessee may therefore enjoy tax benefits such as depreciation deductions.

– Lessee may have the right to purchase the equipment at the end of the lease term.

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GUARANTYGUARANTY

Guarantor becomes liable for the obligation of another person, the primary debtor. A guaranty must be in writing and allows the party that is to receive payment to look to the guarantor in the event the primary debtor fails to pay. Terms and amount of liability is stated in the guaranty agreement.

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Payment versus Collection– Guaranty of payment - the guarantor’s obligation to pay the

lender is triggered, immediately and automatically, when the primary debtor fails to make a payment when due.

– Guaranty of collection - the guarantor becomes obliged to pay only after the lender has attempted unsuccessfully to collect the amount due from the primary debtor.

Continuing vs. Restricted– Restricted guaranty - enforceable only with respect to a

specified transaction or series of transactions. – Continuing guaranty - covers all future obligations of the

primary debtor to the lender.

GUARANTYGUARANTY

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Fraudulent Conveyances - direct or indirect transfer of assets to a third party with the actual intent to, or the effect of, hindering, delaying, or defrauding creditors by putting the assets out of the creditors’ reach. A leveraged buyout can be attacked as a fraudulent conveyance.

Preferences - transfer from a debtor to an outsider creditor that results in a reduction in the guaranty liability of an insolvent insider. If within one year of the filing of bankruptcy it may be voidable.

GUARANTYGUARANTY

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SUBORDINATIONSUBORDINATION Debt subordination - agreement whereby one or

more “junior” creditors of a common debtor agree to defer payment of their claims until the “senior” creditor of the same debtor is fully paid. As long as the debtor is solvent, both the junior debt holder and the senior debt holder can expect to be paid.

Indebtedness to Insiders - lenders will require that debt to insiders (officers, directors and shareholders) be subordinated to the lender’s debt.

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Lien Subordination - agreement between two secured creditors whose respective security interests, liens, or mortgages attach to the same property.

Equitable Subordination - creditor’s claim that is involuntarily postponed in bankruptcy law to prevent one creditor, through fraud or other wrongful conduct, from increasing its recovery at the expense of other creditors of the same debtor.

SUBORDINATIONSUBORDINATION

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BUSINESS BANKRUPTCIES

BUSINESS BANKRUPTCIES

There are two major types of business bankruptcies: liquidation under Chapter 7 and reorganization under Chapter 11.

Good Faith Requirements - bankruptcy law specifically authorizes the court to convert a case under Chapter 11 to a case under Chapter 7 or to dismiss a case for cause.

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GOOD FAITH REQUIREMENTS


Case 26.1 Synopsis--SGL Carbon Corp.SGL manufactures and sells graphite electrodes used in steel production. In 1997, the US DOJ commenced an investigation of alleged price-fixing by graphite electrode manufacturers, including SGL. SGL German parent SGL AG recorded a charge in Deutschmarks of approximately $240 million as its “best estimate” of the SGL potential liability in the criminal and civil antitrust litigation. . . . SGL filed a voluntary Chapter 11 bankruptcy petition in the US District Court for Delaware. In SGL’s Disclosure Statement, in a section addressing “Factors Leading to [the] Chapter 11 Filing,” SGL Carbon only discussed the antitrust litigation. The proposed plan also barred any claimant from bringing an action against SGL Carbon’s affiliates, including its parent SGL AG, “based on, relating to, arising out of, or in any way connected with” their claims against SGL Carbon.

CONTINUED

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Case 26.1 (Cont’d) In a press release SGL explained it had filed for bankruptcy “to protect itself against excessive demands made by plaintiffs in civil antitrust litigation and in order to achieve an expeditious resolution of the claims against it.” ISSUE: The threshold issue is whether Chapter 11 petitions may be dismissed for “cause” under 11 U.S.C. § 1112(b) if not filed in good faith. . . . May a Chapter 11 petition be dismissed if not filed in good faith? What constitutes bad faith? HELD: SGL’s bankruptcy petition was DISMISSED. The court held that the “[reorganization] plan’s differing treatment of creditors suggests SGL Carbon’s petition was not filed to reorganize the company but rather to put pressure on antitrust plaintiffs to accept the company’s settlement terms.”



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CHAPTER 7 LIQUIDATIONS


Petition. A bankruptcy case is initiated by filing a petition.– A trustee is appointed to administer the

estate.– Chapter 7 is sometimes called a straight

bankruptcy all the debts are discharged and the slate is wiped “clean.”

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Individual Debtors - discharged from all obligations except:– Taxes;– Educational loans (unless repayment would

constitute an undue hardship);– Spousal or child support;– Fines or penalties;– Drunk-driving liabilities; and– Claims arising from fraud, theft, or willful and

malicious injury.

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CHAPTER 7 LIQUIDATIONS Limits.

– Chapter 7 is only available to debtors who have received a discharge in a bankruptcy filed in the preceding six years.

– Not allowed if the debtor has committed fraud or is concealing or destroying property

Exempt Property - excluded from the bankruptcy estate and intended to provide for the individual’s future needs. Generally includes a homestead, a motor vehicle, household or personal items, tools of the debtor’s trade, health aids, personal injury awards, alimony or support payments, disability or retirement benefits (including IRAs), life insurance or annuities, and some special deposits or cash.

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Reaffirmation Agreement - contract with a creditor whereby the debtor agrees to repay a debt even though the debt would otherwise be discharged in the debtor’s bankruptcy case. The creditor must file the reaffirmation agreement with the bankruptcy court, which has the power to disapprove it if the court finds that the agreement is not in the debtor’s best interests.

Non-Individual Debtors - Chapter 7 does not provide a discharge for corporations, partnerships, or similar business entities.

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CONSUMER BANKRUPTCY UNDER

CHAPTER 13


CHAPTER 13 Chapter 13 deals with adjustments to the debt of an individual or married

couple with regular income. Chapter 13 Requirements

– Individuals with regular income with up to $100,000 of unsecured debt and secured debt of $350,000.

– Provides a repayment plan for repaying creditors.– Plan generally allows debtor to retain all of his or her assets.– Debtor’s future disposable income must be paid to a disbursing trustee

for the next three to five years.– After completing all plan payments, the debtor obtains a Chapter 13

discharge.– Chapter 13 is a “super discharge” of claims for fraud, theft, willful and

malicious injury, or drunk driving, but not spousal or child support.

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CHAPTER 13


CHAPTER 13 Advantages of Chapter 13

– Filing of a bankruptcy petition stops all creditor collection activity.

– Unlike Chapter 7, Chapter 13 debtor does not surrender any assets.

– Can convert to Chapter 7 if unable to make payments.

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CHAPTER 11 REORGANIZATIONS


Designed for reorganizing troubled businesses, from single-asset limited partnerships to huge publicly held corporations. The treatment of the debtor’s creditors and holders of ownership interests and the future of its business are set forth in a plan developed by one or more of the parties.

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The Plan– Claims and equity interests are divided separate classes according to

their legal attributes.– A plan also must prescribe treatment for the claims and interests in each

class.– A reduction in the amount payable is known as a composition.– In many cases, creditors exchange all or part of their claims for preferred

or common stock or other ownership interests in the business.– Plans often provide for payments from cash on hand, future earnings,

asset sales, new capital contributions, or some combination of sources.– The plan must be feasible and in the best interests of the creditors.– Creditors and shareholders are entitled to receive a disclosure statement

with adequate information to enable them to make an informed judgment.

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Cramdown Confirmation - although difficult and unusual, the reorganization plan can be confirmed by a “cramdown” over the objections of creditors.

Discharge - confirmation under Chapter 11 can give reorganized debtors a new financial beginning under the plan. For individual debtors, however, the same debts that would be nondischargeable under Chapter 7 are excluded from the Chapter 11 discharge.

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CRAMDOWN CONFIRMATION


Case 26.2 Synopsis. Bank of America v. 203 North Lasalle Partnership.BANTSA was the major creditor of 203 North LaSalle Street Partnership (Partnership), an Illinois real estate limited partnership. The value of the Partnership property mortgaged to the bank was less than the balance due, leaving the bank with an unsecured deficiency of $38.5 million. The Partnership sought to cram down over the bank’s objection a plan whereby (1) the bank’s $38.5 million unsecured deficiency claim would be discharged for an estimated 16 percent of its present value; and (2) certain former partners of the Partnership would contribute $6.125 million in new capital over the course of five years, in exchange for the Partnership’s entire ownership of the reorganized debtor. CONTINUED

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Case 26.2 (Cont’d) The old equity holders were the only ones given the right to contribute new capital in exchange for equity. ISSUES: May a debtor’s prebankruptcy equity holders, over the objection of a senior class of impaired creditors, contribute new capital and receive ownership interests in the reorganized equity, when that opportunity is given exclusively to the old equity holders under a plan adopted without consideration of alternatives? HELD: The plan could not be approved over the objections of the bank.

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OTHER CHAPTERS OTHER CHAPTERS Chapter 12, a hybrid of chapters 11 and 13,

provides debt adjustment, but not a superdischarge, for family farmers (a technically defined term) whose aggregate debts do not exceed $1.5 million.

Chapter 9, largely patterned after Chapter 11, provides debt adjustment for municipalities.

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BANKRUPTCY PROCEDURES BANKRUPTCY PROCEDURES

Bankruptcy also offers several other advantages for debtors.

Automatic Stay - The most immediate and dramatic advantage of any bankruptcy filing is the automatic stay, which instantly suspends most litigation and collection activities against the debtor, its property, or that of the bankruptcy estate. Creditors must honor the automatic stay. Failure to do so can be costly.

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AUTOMATIC STAYAUTOMATIC STAYCase 26.3 Synopsis. In Re Computer Communications, Inc.

Codex designs and manufactures communication equipment and networks. Codex entered into a joint marketing and development contract with CCI. Codex was supposed to make minimum quarterly purchases of equipment and software for CCI for incorporation into Codex products. Two days after the last amendment and extension of the contract, CCI filed for Chapter 11. Codex terminated the contract. ISSUE: Does unilateral termination of an agreement with a debtor who has filed for bankruptcy violate the automatic-stay provision? HELD: YES. Codex violated the automatic stay and was liable for the debtor’s loss of projected profits and for punitive damages.

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BANKRUPTCY PROCEDURESBANKRUPTCY PROCEDURES

Proof of Claims - used by creditors instead of lawsuits to dispute bankruptcy filing. Filed claims are deemed valid or allowed unless and until someone objects. Disputed claims normally are resolved through a quick hearing before the bankruptcy judge.

DIP Control - usually the trustee is in control unless a debtor in possession (DIP) is appointed by the court.

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DIP CONTROLDIP CONTROLCase 26.4 Synopsis. In Re Marvel Entertainment Group Inc.

After Marvel filed for bankruptcy, tensions arose among some of the creditors. One creditor assumed control of Marvel, assuming the roles of DIP and creditor. Settlement negotiations broke down and the DIP filed adverse litigation against the other creditors. The other creditors petitioned for a trustee to be appointed since the DIP could not be neutral. The district court granted the trustee request. ISSUE: Is acrimony between the DIP and certain creditors sufficient cause to justify appointment of a trustee? HELD: DISMISSAL AFFIRMED on appeal because it was in the best interests of the creditors and the estate to have a trustee, even though this should be the exception and not the rule in this type of case.

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Obtaining Credit - a DIP’s priority is to stay in business and generate cash flow and work with customers and seek to secure unsecured credit from suppliers. Assets acquired after the bankruptcy petition is filed are not subject to the pre-petition security agreements that cover such after-acquired property.

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Avoiding Powers - DIP’s ability to invalidate or reverse certain pre-bankruptcy transactions.– Strong-Arm Clause - DIP is granted the rights of a hypothetical

creditor who extended credit to the debtor at the time of bankruptcy and who, as a result, either obtained a judicial lien on all property in which the debtor has an interest or obtained an execution against the debtor that was returned unsatisfied.

– Fraudulent Transfers - DIP may seek to avoid fraudulent transfers or obligations that occurred within a year of the filing whose purpose was to hinder, delay, or defraud creditors or provide less than reasonably equivalent value in exchange.

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AVOIDING POWERSAVOIDING POWERS

– Preferences - transfers to (or for the benefit of) creditors on account of antecedent debts that are made from an insolvent debtor’s property within ninety days before bankruptcy and that enable the creditors to receive more than they would through a Chapter 7 liquidation.

– Setoff Rights - creditor automatically deducts what the debtor owes the creditor from what the creditor owes the debtor.

– Statutory Liens - certain liens can be avoided by the DIP.

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AVOIDING POWERSAVOIDING POWERSCase 26.5 Synopsis. Adams v. Anderson (In re Superior Stamp & Coin Co.)

Superior Stamp & Coin operated as a full service auction house specializing in the auction of coins, sports and Hollywood memorabilia, and related goods. Adams and Superior entered into an auction consignment agreement, whereby Superior agreed to auction Adams’s coin collection and pay Adams the net proceeds within thirty days after receiving the funds. After Superior failed to remit the net proceeds, Superior negotiated a repayment schedule with Adams which called for Superior to remit the proceeds in six equal payments. Later, Superior was under severe financial strain, and its largest creditor, the Bank of California, was actively involved in Superior’s day-to-day management. In an effort to preserve Superior’s business, the bank agreed to fund certain repayments, including the installment owed Adams. In spite of the efforts to save Superior, the company failed.

CONTINUED

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AVOIDING POWERSAVOIDING POWERSCase 26.5 (Cont’d)

Superior filed an involuntary petition for Chapter 11 bankruptcy. The trustee sought to recover the payments to Adams on the grounds that they were voidable preference transfers. Adams argued that the bankruptcy doctrine of earmarking immunized the transfers funded by the bank from avoidance. ISSUE: Does the earmarking doctrine apply when a debtor requests a loan to pay a particular creditor, and the lender does not pay the creditor directly but advances the funds to the debtor for payment to the selected creditor? HELD: FOR ADAMS. The in payments made by the bank to fund the checks to Adams fell within the earmarking doctrine and were not voidable preferences.

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Executory Contracts and Leases - DIP has the option of assuming or rejecting prebankruptcy executory contracts—that is, contracts that have not yet been performed—or unexpired leases. Assumption preserves the debtor’s rights and duties under the existing relationship, whereas rejection terminates them. Is an option to buy property an executory contract?

Sale of Property - the DIP can sell both interests and disburse the net proceeds proportionately or sell property free and clear of liens or other interests (which normally will be shifted to the proceeds).

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WORKOUTSWORKOUTSAn out-of-court settlement that restructures the debtor’s financial affairs in much the same way that a confirmed plan would, but it can bind only those who expressly consent. The right to file bankruptcy cannot be waived; regardless of its terms, a workout agreement cannot stop the debtor from taking refuge in Chapter 11 if the restructured obligations prove too great.

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LENDER LIABILITY LENDER LIABILITY Breach of Contract - lender’s failure to act or to refrain from acting as

required by the terms of a loan document or other agreement. Breach of Duty of Good Faith - requires the lender to act reasonably

and fairly in dealing with the borrower and in exercising its rights and remedies under the loan documents and under applicable law.

Fraudulent Misrepresentation - lender may be liable to the borrower if it represents that it will make a loan available to the borrower when, in fact, it has decided not to extend any credit to the borrower.

Economic Duress - coercion of the borrower by threatening to do an unlawful act that might injure the borrower’s business or property. Compensatory and punitive damages may be recovered for economic duress.

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LENDER LIABILITYLENDER LIABILITY Tortious Interference - lenders can be liable for wrongful or

tortious interference with the borrower’s corporate governance. Intentional Infliction of Emotional Distress - lender liable when

bank officials publicly ridiculed borrower, pointing at him, using profanities, and laughing about his financial difficulties.

Statutory Bases of Liability - e.g., RICO and CERCLA. Also a lender may be subject to penalties in cases brought by the SEC for aiding or abetting a borrower in violating federal securities laws if it knew, or should have known, that a violation was taking place or if it is found to be a controlling person with respect to the borrower.) has been used by private litigants in lender liability cases.

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SPECIAL DEFENSES AVAILABLE TO THE FEDERAL INSURERS OF FAILED BANKS AND SAVINGS

AND LOANS

SPECIAL DEFENSES AVAILABLE TO THE FEDERAL INSURERS OF FAILED BANKS AND SAVINGS

AND LOANS The D’Oench, Duhme doctrine— used by federal regulators to increase the value of failed banks or savings and loans by easing the federal agencies’ ability to collect on loans. Bars enforcement of any agreements (including secret agreements) unless those agreements are in writing and have been approved contemporaneously by the bank’s board or loan committee and recorded in the bank’s written records.

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THE RESPONSIBLE MANAGER

THE RESPONSIBLE MANAGER

Managing Debtor–Creditor Relations A responsible manager must understand lender liability risks. The following steps will help lenders minimize those risks.– Lender should indicate clearly that any commitment must

be in writing and approved by the loan committee or other appropriate officials of the lender.

– Lender should avoid clauses that attempt to control the borrower’s management decisions or day-to-day business activities.

– Loan documents should provide that any amendment, modification, or waiver should be signed by both parties.

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THE RESPONSIBLE MANAGER (continued)

THE RESPONSIBLE MANAGER (continued)

Managing Debtor–Creditor RelationsA responsible manager must understand lender liability risks. The following steps will help lenders minimize those risks.– Lender may ask the borrower to agree to waive its right to a

jury trial and substitute a binding arbitration clause.– Lender’s documents should be accurate and complete;

virtually all the documents in the lender’s files may be subject to legal discovery.

– Lenders should refrain from giving any legal, financial, or investment advice to the borrower.

– Consider Chapter 11 as a strategic option for creative business planning.

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REVIEWREVIEW

1. What are affirmative and negative covenants?

2. Security interests can be perfected in what

three ways? 3. Where would you file a security interest in

timber?

Documents

CHAPTER 26 Debtor-Creditor Relations and Bankruptcy